Best & Worst Funds: Information Technology Sector

DavidTrainer

Infor­ma­tion Tech­nol­ogy is my top-ranked sec­tor. As detailed here, only it and the Con­sumer Sta­ples sec­tor get my Attrac­tive rat­ing. Sec­tor rat­ings, like fund rat­ings, are based on aggre­ga­tion of my rat­ings for each of the stocks. All other sec­tors are rated Neu­tral or Dangerous.

The tech sec­tor has a uniquely strong com­pet­i­tive posi­tion vs. all other sec­tors. I think of it as a play on growth oppor­tu­ni­ties within every sec­tor. What indus­try does not rely on tech­nol­ogy for some part of its oper­a­tions? Tech­nol­ogy is embed­ded in nearly every­thing we do. There are excep­tions, but that list is shrink­ing as tech­no­log­i­cal inno­va­tion is mak­ing processes bet­ter all the time. The bot­tom line is the best com­pa­nies are those that inno­vate the most, and tech­nol­ogy com­pa­nies are the most inno­v­a­tive com­pa­nies by a wide margin.

There are 170 funds to chose from within the Infor­ma­tion Tech­nol­ogy sec­tor, and they are all very dif­fer­ent. Per Fig­ure 1, the num­ber of hold­ings varies widely (from 17 to 421), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Here is the full list of 170 funds.

How do investors pick the right fund out of the sea of choices that will deliver the best returns?

Fig­ure 1: Funds with Most & Least Hold­ings - Top 5

Sources: New Con­structs, LLC and com­pany filings

To iden­tify the best funds within a given cat­e­gory, investors need a pre­dic­tive rat­ing based on analy­sis of the under­ly­ing qual­ity of stocks in each fund. See Figure 2.

Our pre­dic­tive fund rat­ings are based on aggre­gat­ing our stock rat­ings on each of the fund's hold­ings and all of the fund's expenses. Investors deserve forward-looking fund research that is com­pa­ra­ble in qual­ity to stock research. Investors should not rely on backward-looking research of past per­for­mance for invest­ment decisions.

Fig­ure 2 shows the five best- and worst-rated funds for the sec­tor. The best funds allo­cate more value to Attractive-or-better-rated stocks than the worst funds and vice versa, except for STPAX. This fund gets a Dan­ger­ous rat­ing despite a siz­able allo­ca­tion to Attractive-or-better-rated stocks because its total annual cost is a whop­ping 6.9%. My rat­ings (updated daily) on all funds in this sec­tor are here.

One of my favorite stocks in the Tech­nol­ogy sec­tor is Google
GOOG, +0.42%
which gets my Very Attrac­tive rat­ing. Google is the world leader in ana­lyz­ing and syn­the­siz­ing infor­ma­tion, and I believe their skill set is the pre­em­i­nent busi­ness skill set for the 21<sup>st</sup> cen­tury. Mak­ing sense of the mass of data and infor­ma­tion float­ing around in cyber­space is a big job, and there is a lot of money to be made for those that are most pro­fi­cient in doing that.

One of my least favorite Tech­nol­ogy stocks is Verisign
VRSN, +0.84%
which gets my Very Dan­ger­ous rat­ing. The stock is expen­sive and its reported earn­ings are mis­lead­ing. The cur­rent stock price ($36.52 as of the 1/24/2012 close) implies the com­pany will grow its after-tax cash flow (NOPAT) by 15% com­pounded annu­ally for nearly 10 years. Those are high expec­ta­tions for a com­pany whose aver­age growth rate over the last five yeas is -19%. Mak­ing mat­ters worse is management's poor cap­i­tal-allo­ca­tion track record. Since 1998, the com­pany has piled up over $15 bil­lion (after tax) in asset writedowns, which means man­age­ment has writ­ten off over $10 for every $1 on its books. That is seri­ous share­holder value destruc­tion. Against that back­drop, it is hard to bet on 15% com­pounded annual growth in NOPAT.

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